California’s budget went from an assumed $98 billion surplus, in which there was so much cash in state coffers that Gov. Gavin Newsom was giving away $50,000 to randomly selected individuals to get a COVID-19 vaccine, to a projected $73 billion deficit in only about two years.

Much of this could have been avoided if, in 2022, California hadn’t made obvious, enormously unrealistic revenue assumptions for future years that falsely painted far too optimistic a fiscal portrait for the state. In a nutshell, here is what happened: in fiscal year 2021‒22, state tax revenues rose around 55 percent—about $70 billion—over the previous fiscal year. This revenue windfall significantly reflected taxpayers realizing capital gains, particularly high-income taxpayers who were facing a marginal tax rate of 13.3 percent at the time.

For decades, California’s revenues have been driven by a capital gains roller coaster in which revenues spike in years in which the stock market booms and investors sell stocks and other assets, after which capital gains revenues decline. The 2021‒22 fiscal year was the mother of all capital gains roller coaster peaks. It seems obvious that the revenue roller coaster would decline after that, particularly with the stock market falling about 23 percent between the end of 2021 and mid-June 2022, when the 2022‒23 fiscal year budget was signed.

However, Newsom’s budget staff assumed that the revenue bonanza from 2021 would not just continue but would grow to an even bigger bonanza in future years. These revenue assumptions were patently unrealistic, particularly with the........

© Hoover Institution